Martin Whitman Quarterly Letter: Comments on Sycamore Networks, Inc. and MBIA Inc.
Much of Whitman’s Third Avenue Value fund is invested in East Asia (53% of the total), specifically, 37% in seven real estate and private equity companies headquartered in Hong Kong, 9% in Toyota Industries, and 6% in s South Korea steel company Posco. Whitman wants to participate in the China boom but he is afraid of the macro social and political risk in that country. His solution is to invest in property developers headquartered in Hong Kong.
Distressed debt has been a bright spot for the fund. Whitman discussed his investment in Senior Notes in Forest City, Nortel, and GMAC, all of which brought hefty profit for the fund. Distressed debt investing is Whitman’s expertise and his investment in this area is paying off.
Whitman spent a good portion of his letter on explain his investment in two common stocks --Sycamore, MBIA, and a joint venture called “Fleetwood”. Since equity investing is what our users come to GuruFocus for, we provide an excerpt for the comments of the common stocks:
Sycamore Networks, Inc. (SCMR)
Whitman bought 5million share more for the quarter ended on October 30, 2009. Here is what he said about the investment:The main attraction of Sycamore Common to Fund Management is the company’s balance sheet. At fiscal year end, Sycamore had $927 million in cash and government securities ($3.26 per share) compared to $31 million in total liabilities. The company also had federal and state net operating losses (“NOLs”) of $768 million and $187 million, respectively.
Sycamore’s management is aligned with outside passive minority shareholders through management’s 31% common stock ownership and very modest cash compensation. Chairman Gururaj Deshpande and CEO Dan Smith previously ran Cascade Communications, which was ultimately sold in a very profitable transaction for shareholders. At Sycamore, Deshpande and Smith have avoided making expensive acquisitions and have rightsized the business to minimize cash burn ($17 million in fiscal 2009). The company recently announced a 30% headcount reduction including the closure of its New Jersey office. Employee headcount is expected to decline to 300 from 492.
After the special dividend, the company still have $600 million that according to Whitman, should enable it to grow both organically and through acquisition.
MBIA Inc. (MBI)
The love-hate relationship continues between MBIA Inc. and Whitman. Whitman wrote about the situation before and he provided an recap in this quarter’s letter, so here are his thoughts:As we have previously written about in prior letters, in February of this year, MBIA, Inc. effected a transaction in which over $5 billion of liquid assets were removed from MBIA Corp., as was virtually all the profitable going concern business of MBIA Corp. That transaction is now the subject of multiple litigations. Put simply, if MBIA,
Inc., the parent company, can get away with the asset stripping from its principal insurance subsidiary, which was approved by the New York Insurance Department on February 19th, MBIA Corp.’s ability to make good on its liabilities for losses realized in guaranteeing structured finance obligations (almost all are guarantees of residential
mortgage obligations as well as commercial and real estate obligations) and international finance obligations will have been severely impaired. MBIA Inc. itself characterizes the asset stripping as “ring fencing” MBIA Inc. from all structured finance obligations. On the one hand, if MBIA Inc. can be blocked from the asset stripping, it seems probable that MBIA Common is valueless. On the other hand, if MBIA can get away with the asset stripping, MBIA’s adjusted book value might be around $20 per share and MBIA would be left with a very well-capitalized going concern insurance subsidiary guaranteeing only municipal obligations. We believe that there is a strong possibility that MBIA will be unable to defend the claims brought by the various plaintiffs challenging the transaction. On that basis, Fund Management decided that it ought to start to sell MBIA Common at prices of $5.90 per share or better.
Three suits against the MBIA asset stripping have been brought by a hedge fund, nineteen major banks, and Third Avenue, which owns $362.2 million of insurance subsidiary Surplus Notes. It is MBIA’s position that the asset stripping is a “done deal” because it was approved (in a secret process) by the New York Insurance Department, and can only be set aside in an Article 78 proceeding whereit has to be shown that the actions of the Superintendent of Insurance were “arbitrary and capricious”. Regardless of the outcome, Fund Management was able to sell 73% of the Fund’s holdings of MBIA Common. Fund Management will continue to be opportunistic in selling the remaining holdings of MBIA Common.
During the credit and financial crisis in the past two years, Whitman’s investment in Senior Notes has been largely successful. His investment in common stocks in distressed companies such as Radian Group, MGIC Investment, and MBIA Inc. has been largely a failure. The Third Avenue Value Fund, however, has recovered decently. YTD (through December 2, 2009), the fund is up 41%.
It lost 45.6% in 2008.
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